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10.6 End-of-Chapter Material

In Conclusion

The minimum wage is a public policy that is debated the world over. It has widespread public support because there is something very appealing about the notion that those who work hard will be rewarded with a reasonable standard of living. Economists, living up to their reputation as dismal scientists, point out that this is all very well, but there may be unintended consequences of such a policy:

  • A minimum wage leads to a reduction in employment and to unemployment.
  • A minimum wage leads to fewer trades than in a competitive market and therefore to inefficiency.

The theory of the minimum wage is straightforward and convinces most economists that, even if the minimum wage has some benefits in terms of the distribution of income, it carries costs with it as well. There is less consensus among economists about whether the redistribution brought about by the minimum wage is desirable. Although the working poor benefit, others are made worse off—including those who are unemployed, who are perhaps even more in need of help than the working poor. Individuals differ in their beliefs about how society’s resources should be distributed, and there is no right answer to the question “what is fair?”

When we looked at the evidence on minimum wages, however, we found that the picture is much less clear. Although some studies are in line with the predictions of theory, many studies suggest that, in practice, the effect of the minimum wage on employment is minimal. At the same time, the effect of the minimum wage on the distribution of income is small as well. In the end, it is difficult to resist concluding that the minimum wage is much less important—in terms of both benefits and costs—than one would think from the rhetoric of the debate.

When you read the newspapers or watch television, you will frequently hear economists offer different viewpoints on economic policies. These disagreements are typically not because economists differ on the theory. The disagreements often come down to different opinions about how to analyze and interpret economic data. Remember as well that television and print journalists go out of their way to find differing points of view because that makes a better story, so the disagreement you see in the media is usually not representative of economists as a whole. That said, economists also have different political viewpoints, and they are sometimes guilty of letting their political preferences cloud their economic analysis.

Having gone through the arguments in this chapter, you should be better able to assess debates and discussion on the minimum wage the next time it comes to the forefront of public debate. This chapter has a much broader purpose, however. We have been studying the effect of government intervention in a market, and we have shown how we can use our tools of supply and demand to understand the likely effects of that intervention. There are many other examples of government interventions that can be investigated using very similar reasoning.

Finally, we have learned something about how empirical work is conducted in economics. Because economists cannot conduct experiments, they are forced to trawl through messy data in an attempt to test their theories. It is difficult to be sure that the variables in which we are interested are indeed changing enough to be useful, and it is even more difficult to disentangle those changes from all the other irrelevant changes that affect the data that we observe.

Key Links

Exercises

  1. List three jobs you think probably pay minimum wage and three jobs that you think do not.
  2. Illustrate an increase in the minimum wage when both demand and supply are (a) relatively inelastic and (b) relatively elastic. Explain why the change in unemployment is smaller when the curves are inelastic.
  3. Explain why the deadweight loss from the minimum wage is larger if labor demand is relatively elastic.
  4. How does the elasticity of labor supply affect the deadweight loss from the minimum wage? Specifically, if labor supply is more elastic, is the deadweight loss smaller or larger? What is the economic intuition behind your answer?
  5. (Advanced) Draw a version of Figure 10.9 "Deadweight Loss from Minimum Wage" for the case where a single individual controls access to scarce jobs. Suppose that she is able to charge job searchers a fee (the same fee for all searchers) equal to the difference between the minimum wage and the wage that workers would be willing to accept. What area of the figure does she obtain?
  6. In our discussion of the evidence of the effects of minimum wage changes, we said, “If economists could conduct direct experiments, such as those performed in the physical sciences, they would not have this problem.” Exactly what problem were we referring to?
  7. What is the difference between cross-sectional and time-series studies? Does one hold “more things fixed” than the other?
  8. Suppose the government imposed a maximum wage in the market for some high-paying job. Draw a diagram to illustrate this market. What would be the consequences of this maximum wage?
  9. Explain why, when we analyze the minimum wage, the elasticity of labor supply affects the unemployment rate but not the employment rate.
  10. Why does the government not set a minimum wage for corporate lawyers and airline pilots?
  11. If the rate of inflation is 10 percent higher than expected, and –(elasticity of labor demand) is 5, what will happen to the employment level in jobs that pay the minimum wage?
  12. What happens to the rate of unemployment of minimum wage workers if the rate of inflation is lower than expected?
  13. Does the elasticity of labor supply have an effect on the change in the wage bill when there is an increase in the minimum wage? Does this elasticity have an effect on the unemployment rate when the minimum wage changes?
  14. (Advanced) Using the discussion of estimation of labor demand, if you could conduct an experiment to see the effects of a minimum wage increase, what exactly would you do?
  15. (Advanced) Using supply and demand curves in the market for fast food, what are the effects of an increase in the minimum wage in this market? Think about shifts in both the supply curve and the demand curve. Explain your predictions.
  16. Why isn’t an increase in the minimum wage just a redistribution from firms to workers?
  17. A politician is in favor of getting rid of the minimum wage entirely. How would you argue against that proposal?

Economics Detective

  1. Pick three countries and find the minimum wage in each country.
  2. Find a country that does not have a minimum wage. Do you think the lack of a minimum wage means that workers are badly treated in that country?
  3. Find some recent discussion of minimum wage legislation in either the United States or some other country. What arguments were made to support the minimum wage? What arguments were made against the minimum wage?

Spreadsheet Exercise

  1. (Advanced) Find data on the minimum wage and the price level for another country. Construct a real minimum wage series for that country.